CPP enhancement saves Ontario from itself

July 04, 2016

On June 21st, 2016, Ontarians celebrated as the provinces and the federal government came together with a tentative agreement to enhance the Canadian Pension Plan (CPP). The excitement in Ontario is not so much about the implementation of an enhanced CPP as it is about the termination of the province’s own creation—the Ontario Retirement Pension Plan (ORPP). Finance Minister Charles Sousa confirmed that if the CPP deal is formally signed on July 15th, 2016, the ORPP will be dismantled.

Details of the agreement

The enhanced CPP raises the benefit rate from 25 to 33 percent of earnings. This will be achieved by increasing the contribution rate from 4.95 to 5.95 percent for both employers and employees, bringing the total contribution rate up to 11.9 percent of pensionable earnings. Moreover, the maximum pensionable earnings will be increased by 14 percent.[1]

The enhancement will be phased in extremely slowly and cautiously. Starting in 2019, the contribution rate will gradually increase over five years until it reaches 5.95 percent; then over the following two years, the maximum pensionable earnings limit will be raised by 14 percent (in real terms). For those earning at or above the new pensionable earnings limit (starting in 2025), the total CPP pension one can expect to receive will increase by approximately 50 percent.[2]

Who is better-off?

Higher CPP benefits as a result of higher contributions are not examined here. Whether somebody is better off by saving more today in order to spend more in retirement is subjective. We want to examine how the new CPP affects workers’ well-being through interactions with other policies.

Low-income workers

Low-income workers, that is, individuals earning less than $18,292 or families or single parents earning less than $28,209, are eligible for the Working Income Tax Benefit (WITB). To offset the reduction in disposable after-tax income due to the CPP increase, the government has proposed an expansion to the WITB. However, when lower-income individuals retire, they may not be better off as a result of the CPP enhancement.

For every dollar increase in CPP income (which is taxable) in retirement, an individual’s guaranteed income supplement (GIS, which is non-taxable) is reduced by 50 cents. So lower-income individuals will benefit today from the increased WITB, but lose out on some of the GIS in retirement—it is too soon to say which effect will outweigh the other.

Moderate-income workers

This earnings group is not eligible for the WITB; however, some may be eligible for the GIS in retirement. This group cannot benefit from the increase in the WITB, but may be made worse off by the reduction in the GIS benefit.

High-income earners

Currently, a non-refundable tax credit for CPP contributions is in place. These credits are set at the lowest personal income tax brackets’ rates, both federally and provincially. Under the new agreement, the second tranche of CPP contributions—the 14 percent increase in maximum pensionable earnings—will be eligible for a tax deduction. The marginal tax rate on earnings in this new tranche is much higher, and as such, the tax credit/deduction should reflect this. Also, if individuals substitute an enhanced CPP for a reduction in RRSPs (which are tax deductible at the marginal income tax rate), they will not become worse off. Basically, higher-income earners should not expect to benefit or lose out from the changes.

Why is the CPP enhancement better than the ORPP for Ontario?

Level playing field

The CPP enhancement maintains a level playing field between provinces. If the ORPP had gone forward, firms in Ontario would have faced an additional cost (1.9 percent ORPP contribution rate from both employees and employers) over their interprovincial competitors.

Less costly

The ORPP would have been administratively burdensome and costly to run. CPP enhancement adds essentially no new administrative costs as there is already a structure (investment board) in place. The enhancement is as easy as withholding a slightly higher percentage of earnings as contributions. The continuation of the ORPP Administration Corporation (ORPP AC), on the other hand, would require a full staff and additional costs associated with running a corporation. The ORPP AC would have had to assess every single firm and identify whether or not they would be exempt from the program. On the other hand, the CPP enhancement simply applies to everybody.

More flexible

Employees can move across firms and provinces seamlessly, without having to opt in and out of the ORPP. Also, a province-by-province approach would have reduced worker mobility, and collecting multiple provincial pensions would be confusing come retirement time.

The enhanced CPP meets the needs of Ontarians

Ontario now has a plan to strengthen retirement security, which was a key policy in both the provincial and federal governments’ platforms. Scrapping the ORPP means the province will save millions per year in administrative costs. Interestingly, the outcomes of the new CPP may be similar to the ORPP’s intention. Workplace pension plans may be dialed down to account for the CPP enhancement, which could result in minimal changes for those workers who were already covered; whereas those with no workplace plan will be targeted by the new program. The gradual phase-in will mean that the economy should not be adversely affected and critically for Ontario, regional competitiveness concerns will not be an issue.

[1] In 2016 dollars, this would represent an increase from $54,900 to $62,586.

[2] The combination of increasing the income that is pensionable by 14 percent and the benefit rate from 25 percent to 33 percent lead to this result. $54,900 is not actually used to calculate benefits, but rather the average earnings threshold of the last 5 years. This example is for illustrative purposes only.